Background.

The COVID-19 pandemic has caused many employers to ask – or require – employees to work from home. Further, employees are requesting – or demanding – to work from home. These changes in employee work locations implicate numerous state and local tax issues if the employee lives in a state (or locality) different from the physical location where the employee had previously worked.

What are some examples of issues that could arise when an employee’s residence state (or locality) differs from the employee’s original state (or locality) of employment?

1. Employer withholding. For example: The employee begins working from her home in State A instead of commuting to her employer’s place of business in State B, which she had been doing. Generally, an employer must withhold only in a jurisdiction in which it is doing business. Because the employee could be considered to be conducting business in the taxing jurisdiction where the telecommuting occurs, the taxing jurisdiction may assert that the employer must withhold the payroll tax in the place where the employee lives
2. In determining whether withholding in State A is required – or desired – as a result of this change, the employer should consider:
   
   
   • Whether State A and State B have a reciprocal withholding agreement permitting the employer to withhold only in the state of the employee’s residence.
   • Whether the employer would like to withhold in State A, even if not required to do so, for the convenience of the employee.
   • Whether the employee is working in State A at the convenience of the employer or at her own convenience. This is a critical question of fact, especially for New York (and some other states’) withholding.
   • How many days the employee will work in State A. A bill is pending in Congress (Mobile Workforce State Income Tax Simplification Act) that would provide employers with a safe harbor from being required to withhold income tax until the employee has worked in the state for a certain number of days. Some states already have safe harbors specific to the state.
3. The same issues arise, and even more frequently, in those states that permit local municipalities to impose a local wage tax. In Ohio, we are actively working with the interested parties to seek a clarification of employers’ responsibilities for withholding local tax.
4. Employer-level tax. Employers should also analyze whether employees’ change in work locations could cause the employer to be subject to tax in new jurisdictions (i.e., the employee activity creates a nexus) or could change its apportionment factors. For example, in cost-of-performance states, changes to employee locations could alter the sales factor, and in states that use the payroll factor, the relocation could also alter the payroll factor.

What’s at stake?

In addition to potential reputational damage, the employer may be subject to tax, interest and penalty for failing to properly withhold or report income, or for failing to collect or pay gross receipts or sales/use taxes at the entity level.